What Role Do Investment Banks Play In The Economy?

You are here because you asked what role do investment banks play in the economy, and in this article we will try and explain everything there is about investment banks and the likes.

KEY TAKEAWAYS

– Investment banks usually take the role of advisors and brokers
– While commercial banks let you open a checking or saving account
– Investment banks usually cater to large corporations and less for individuals

Are you about to enlist investment banking services for your business but are confused about their role in the economy? Well, you have come to the right place. Suppose you are going to do a merger with another company. How do you find out if it’s going to benefit your company? 

Let’s say you do answer that question. How do you raise funds? Who handles the documentation or controls the assets or figures out new investment strategies? Who manages your stocks? Well certainly not you. You neither have the time nor the experience to deal with this. 

We understand that managing a business is hard, and you will feel stuck in this situation. Well, lucky for you, this is where investment banking comes in. We will tell you all about investment banking and the key differences between commercial and investment banking.

We will also cover the various functions of investment banking and how they can benefit the economy and your business. So, keep on reading.

What Is The Difference Between Investment Banking And Commercial Banking?

Investment banks take on the role of advisors and brokers. They help corporations in everyday business dealings such as putting out IPOs, mitigating merger acquisitions, and managing assets. We will explain all of these factors further in the article.

Commercial bank, on the other hand, allows you to open checking and debit accounts. Additionally, they provide businesses, personal and mortgage loans. So, if you are looking to open a savings account, you will have to go to a commercial bank. 

Commercial banks cater to individual people, whereas investment banks are meant for catering to big corporations. Another key difference lies within the regulating authority. The federal government heavily regulates commercial banks. However, the bank themselves can make limited decisions. They serve to protect the people’s interests. 

Whereas investment banks are loosely regulated by the SEC. With loose regulation, investment banks can take more risk and have more room to function than commercial banks. Commercial banks make money by giving out loans and interests, while investment banks make money through brokering deals and getting commissions.

It is essential to note that no bank can act as commercial and investment banks; instead, they exist as separate entities.

What Are The Different Functions Of Investment Banking? 

Investment banking has a wide range of functions through which they play their role in the economy. We will discuss a few of these here.

1. IPOs 

Companies hire investment banks in issuing IPOs – Initial Public Offering. An Initial Public Offering is a way for private corporations to present their shares to the public.

This way, they can attract investors. The transition from private to public is an important one. Hence, they choose these banks based on a few merits: experience, reputation, quality of work, etc. The whole process is mentioned below:

• The banks work on drafting a financial statement for the IPO in the underwriting agreement.
• Next, it files the statement with SEC.
• After approval from the SEC, an offer price is set.
• Once the shares are issued, the bank does an aftermarket stabilization analysis and creates a stock market.
• Finally, it monitors the transition to market competition.
• The bank receives a commission for its services from the company.

2. Underwriting  

Through underwriting, bankers sell stocks or bonds to investors. It’s a way to raise capital. In other words, a corporation takes on financial risk for a fee. It helps to set fair burrowing rates for loans and put a price on investment risk. For underwriting, the bank first makes a prospectus with a price range. 

Then, an investor commits to a firm price. Next, a book of demand is built, followed by the price being set to be cleared. Finally, the funds are allocated. In case the underwriting goes through, it is called firm commitment. If the deal is called off, it is called an all or none situation where the company receives nothing. 

Moreover, a middle ground situation is called best efforts, where the underwriter commits to selling to the offered price but has the choice to return unsold shares without any financial repercussions. 

3. Merger And Acquisitions

When a company wishes to do a merger, it hires an investment bank. The investment bank represents either the buyer’s or the seller’s side. The buyer can acquire smaller companies or specific divisions or assets from other companies. An investment bank has the following jobs during a merger and acquisition:

• They evaluate the merging company. Then, they figure out its actual value and present it to you.
• They drive the best strategy for the merger.
• They help in raising funds for the merger.
• They add new securities to the market.

By executing these services, investment banks help see the merger through and ensure its success.   

4. Risk Management

There is no avoiding the risks that come along in business. However, investment banks can help you manage those risks in a better way.

They are concerned with identifying the company’s probability of running into an adverse event and how it will affect the bank. There are different risks, such as business risk, investment risk, legal and compliance risk, operational risk, etc.

Market risk is the most important and is concerned with variables in the bank. However, they also keep an eye on eternal risk factors such as credit risks. Investment banks control all these; they take measures such as setting up teams. These teams do risk assessments. They identify threats and loss areas and set risk limits.

5. Research

The best decisions are made through research which is why the primary function of an investment bank is research. Personnel carries out thorough analysis by going over the company’s performance reports. Additionally, by keeping an eye on the stock market, investment bankers can help you make a profit by advising on trades and sales.

Investment banks carry out various research like fixed income research, macroeconomic research, qualitative research, equity research. Equity research involves performing ratio analysis, financial modeling, and exploring financial scenarios, while macroeconomics research is concerned with long-term economic growth and economic data analysis.

6. Structuring Of Derivatives

A derivative is a financial contract whose value comes from the underlying asset, which acts as a benchmark for determining a product’s price. For instance, most people use stocks and commodities such as gold, while others use interest rates and market indexes. 

Such derivatives promise a high rate of return. These can prove to be essential financial instruments, as they can be used for hedging and accessing markets. As a result, investment banks are concerned with the structuring of these derivatives. 

They have skilled technical staff working on designing securities with different derivatives. Furthermore, they also add features to it like bonds which brings more investors and improves profit margin.

7. Merchant Banking

Some investment banks also offer merchant banking though, they provide it as a private consultancy to clients. They provide expertise in several areas such as financial, marketing, legal and managerial divisions.

Merchant banking covers the following services:

• Raising finance for a client
• Project management
• Money market operations
• Leasing services
• Handling government consent for industrial projects
• Managing public issue of a company
• Special assistance to small companies and entrepreneurs

8. Asset Management

Asset management is an essential function of investment banks. Their job is to help you decide which assets to purchase, how to manage your portfolio and where to trade. However, before they decide, they create reports on the company’s performance and analyze it.

They also consider your goals, what you are willing to invest in, and how fast you need results. An important factor when deciding to manage your assets is risk appetite – the percentage of risk an individual is willing to accept in exchange for your plan. This way, bankers can best manage your investments.

It is important to note that investment banks deal with all types of documentation. That means filing any document before selling shares with SEC is their responsibility.

How Does Investment Banking Benefit the Economy? 

Investment banks hold a high value in a country’s economy. For example, a country like the USA has over 100,00 banks, whereas Nigeria has around 500 banks.

It means that Nigeria is not well equipped to deal with the countries’ financial situations. However, the USA has hordes of financial advisors to deal with the crisis.

As more and more businesses flourish, they come to rely on investment banks for several reasons. First, the investment banks help generate funds.

Second, a regular bank focuses on just transactions, whereas investment banks take it further by devising models for efficient business ventures.

Second, investment banks help provide security to the company’s products like credit card documents, financial documents, fixed income, etc. Third, they have teams who actively keep an eye on what stocks are worth are buying and which are worth selling. They also check interest rates.

They also help you seek out new clients. Furthermore, since most investments, these days are made through mutual funds rather than individuals. 

Banks help sell these funds in this scenario by figuring out the fair market price, flexibility issues, and competitor strategies. Overall, investment banks help smooth out business management and increase efficiency.

Investment banking takes up a lot of tasks such as documentation, research, and strategizing. This way, the company will not have to dedicate its own time or employees to these tedious tasks; instead, it can invest its resources elsewhere.

How Do Investment Banks Help As An Advisor? 

Businesses can be pretty hectic, and most people do not have the time to keep everything in check, run analyses, and make the best decisions. Nor do they have the experience.

So rather than letting this turn, catastrophic companies enlist the services of investment banks. These play the role of advisors because of their expertise.

If you are looking to merge with a smaller company, then investment banks can help you structure the best deal for your company. They can also gauge assets and determine the worth of each purchase. 

Since they are up to date with market trends, they can better decide where to invest these assets and help you decide whether incoming offers are worth considering. In addition, with advanced financial modes, they can come up with effective marketing strategies.

How Do Investment Banks Help In Raising Capital?

Capital is necessary for running a business; without it, your business is eternally doomed. Investment banks help companies raise funds in several ways. The chief one being is that they act as a broker between sellers and buyers. As a result, they help set the best deals.

Furthermore, they help to add liquidity to the market. You can add liquidity by offering to buy shares at or below the bid price or deciding to sell shares at the ask or above the asking price. Investment banks help match selling securities with buyers. Therefore, they play the role of the middleman.

Where Does Investment Banks Stand In The Future?

If put simply, investment banks hold your hand as you run your business. Therefore, companies heavily rely on banks and will continue to do so in the future. As the banks gather more intel on the market and make the process user-friendly, their place in society will be strengthened.

Conclusion 

Summing it up, investment banking is crucial for today’s economy. These banks perform a variety of functions. For example, they help put out IPOs and can be a guiding hand during mergers.

Moreover, they can help raise funds as well. Furthermore, these banks have full knowledge of your assets to manage them better for better profits.

Armed with knowledge about the stock market and interest rates, employees at the bank can help you develop excellent financial strategies.

All this promises growth for your business and the overall economy of the country. After reading this article, you know all about investment banking and its importance. We hope all your queries were answered. Feel free to reach out for further help.